Paul Meloan – Vested Interest

On Wednesday the GOP dropped the first hints at their massive tax plan. We are still very early in the process, as no bill has been introduced into the House.  What we have so far is a marketing piece written by the PR folks at the Republican Party. Much is unknown and won’t be known until the policy wonks start dissecting and evaluating the bill. Here are some early calls.

Big Winners

Rich People

The highest marginal rates are reduced from 39.6% to 35% and reduces the number of brackets to three. For your average Wall Street dude earning $3 million per year this alone is worth about $115,000 per year (on $2.5 million taxable income at the highest rate) but he loses about half of that unless he moves to Texas or Florida (see below).

What our Wall Street dude really cares about however is the preferred rate on investment income. Here he has dodged the bullet. There is no mention of eliminating the preferred rates (now a max of 23.8%) on qualified dividends and long term capital gains.

Remember when Warren Buffett said he paid a lower tax rate than his secretary? It’s because of the preferred tax rates on investment income. Same for how a guy like Mitt Romney worth $200 million paid an average tax rate of 14% back in 2012. The new rates plus the Affordable Care Act tax on investment income has narrowed the gap somewhat, but investment income is still preferred to working income.

Mitt was able to make his money at preferred rates because he benefitted from the carried interest rule. Acting as the manager of various funds, Mitt’s firm was paid by investors out of a share of the profits the funds earned for them. What makes this so awesome for Mitt is that if the investments lost money the shareholders ate it all. The Wall Street world loves the carried interest loophole because it’s the classic heads-I-win, tails-you-lose proposition.

Heirs of Dead Rich People

The bill would repeal the estate tax: the 40% levy on estates worth more than $11 million that affects a whopping 0.2% (not a typo) of all estates. Yes, it’s a death tax that does not affect 99.8% of Americans but it’s in the plan. Since our Wall Street dude would love to pass along his wealth to his offspring this hair cut is a big deal. No one else in America does or should care one iota about it.

Apple, GE, Google & other Really Big Global Companies

The bill offers a reduction of the corporate tax rate but also offers an inducement to companies to repatriate income currently held offshore. Many of the biggest US companies have billions of untaxed profits sitting offshore away from US taxes.

<begin rant> This scam (engineered through accounting fictions) is what allows companies like Apple to choose where they earn their ‘profits’ and what taxation system to follow. They do this while enjoying the protections of American law and the productivity of American workers and then thumb their nose at the American tax system.  Real American companies pay American taxes.

Oh, and while they call it a one-time tax rate we all know that the day after it ends companies will go back to sheltering income off shore until Congress puts this practice to an end.

Yes, I am typing this on my Apple laptop which I love, and we’re all going to hell. <end rant>

Losers

New Yorkers & Californians

People who pay big state income tax bills get some relief in that their state and local taxes are deductible for federal purposes. That goes away here, which is why people in the above states as well as my home of Maryland will pay more than their rich-dude counterparts in Florida, Texas, Wyoming and other states that have no state income tax. It’s probably total coincidence that states that believe in progressive taxation and have high taxes tend to vote Democrat and those that do not tend to vote Republican.

Big Families

The increase in the standard deduction is offset by the elimination of personal exemptions. Rich people don’t worry about this because they lose their exemptions anyway due to income limits, but middle class families with lots of kids will lose some benefit here.

Middle Class & Working Class Families

The real issue in the plan is what it does not say. It does not offer meaningful changes to the way middle-class and working families are taxed, which is mostly through payroll (FICA, Medicare) taxes and sales & use taxes. These regressive taxes are a huge aspect of most Americans’ tax burden.  A family with two earners and a modest mortgage making $120,000 per year pays about $10,000 in federal income tax and almost that much again in payroll taxes. This bill addresses none of that.

The National Debt

Remember when the GOP offered to shut down our government and not pay the debt we already had because, I don’t know, whatever? That was back in 2011 when another party held the White House and the GOP supposedly fell to pieces about our grandchildren paying down a national debt in the trillions. Get ready to throw another few trillion on the fire because these tax cuts won’t pay for themselves.

What Should You Do?

Nothing, at least not yet. We are now at the part of the processes where both sides will be floating trial balloons to see what resonates with their base and what they can and cannot get away with. It is also unclear as to whether the bill will qualify for the reconciliation process which would allow it to pass the Senate with a simple majority instead of 60 votes (which they won’t get in this environment). Pull up a chair, make some popcorn or open your preferred beverage and watch the show.

<p>Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, located in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.</p>

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